The Journey from Historical Cost Accounting to Fair Value Accounting: The Case of Acquisition Costs

ABSTRACT: This paper describes the increasing use of fair value accounting under U.S. generally accepted accounting principles (GAAP) compared to the traditional use of historical cost accounting. Acquisition costs, especially for financial assets, used to be capitalized as part of the investment asset. However, with the increasing use of fair value accounting, accounting standards for acquisition costs are increasingly requiring the expensing of these acquisition costs. This paper discusses the former and current standards for treatment of these costs.INTRODUCTIONFor many years, U.S. generally accepted accounting principles (GAAP) placed more emphasis on historical cost accounting than on fair value accounting. However, there have been efforts over time to move toward some fair value reporting. In the last two decades, fair value accounting has made great strides in GAAP. In 1993, Financial Accounting Standards Board (FASB) Statement of Financial Accounting Standards (SFAS) No. 115 was issued which allowed for fair value accounting for certain investments in debt and equity securities. Any investments classified as either trading securities or available-forsale securities are adjusted to fair value with a market adjustment at the end of each period. In 2007, SFAS No. 159 was issued. This statement allows reporting entities the option of measuring most financial assets and financial liabilities at fair value.Traditionally, transaction costs paid in the acquisition of investment assets were capitalized as part of the investment cost. However, as recent movements toward fair value accounting have been made, a simultaneous movement toward expensing these costs has resulted. This paper presents some history and thoughts on the change from capitalizing these costs to expensing them. The next section of the paper addresses acquisition costs under historical cost accounting. The following section looks at the requirements for acquisition costs under the fair value option. Then a section describes the treatment of acquisition costs for other classifications such as trading securities, available-for-sale securities, held-to-maturity securities, and equity method investments. These sections are followed by a discussion section and a conclusion.ACQUISITION COSTS-HISTORICAL COST ACCOUNTINGAccounting students are likely first introduced to the treatment of acquisition costs when they leam about the acquisition of property, plant, and equipment to be used as operating assets. In this context, students are taught that all costs necessary to acquire the asset and get it ready for its intended use are capitalized as part of the asset's original book value. For a piece of equipment, the acquisition cost would include not only the purchase price of the asset, but would also include any costs for taxes, shipping, insurance, installation, and testing. Interestingly, accounting standards do not seem to formalize the capitalization of these costs in any standard relating directly to the acquisition of fixed assets. Instead, this concept seems to be formalized in SFAS No. 34 (issued in 1979) which discusses the capitalization of interest. Paragraph 6 of this statement says the following: The historical cost of acquiring an asset includes the costs necessarily incurred to bring it to the condition and location necessary for its intended use (SFAS No. 34, 1979, para. 6).The focus under historical cost accounting is to record assets at amounts that are verifiable and therefore reliable. An objective of historical cost accounting is to take all costs and split them between those that have future value and those that have no future value. Costs with future value will be capitalized, and as appropriate, written off as an expense over the time the periods when the value is provided. Costs with no future value will be immediately expensed.One would assume the rational purchaser would only be willing to pay fair value for an asset and the rational seller would only be willing to sell an asset if the consideration received represents fair value. …